Waiting on the market last week was the right call.

The markets lost ground again as events in Europe and China weighed on market sentiment. The slowing Q1 earnings cycle also produced few reasons for traders to buck the downward trend and buy stocks.

Unfortunately the setup for next week is not looking especially exciting. Last ditch talks in Greece to form a coalition government and escape a new election appeared destined to fail. The leaders of the major parties said on Sunday there was practically no hope for agreement. The failure to form a government means voters will get another chance to put anti austerity elements in charge in a June election.

The odds of Greece leaving the euro are rising rapidly and along with that move would be a default of the recent bailout agreement. Greece citizens do not want austerity and apparently they are willing to undergo extreme financial hardship in place of that austerity. They may find that what they are asking for is far more painful than austerity. Recent polls claim the citizens want Greece to remain in the euro but they don't want the bailout or the forced austerity. Unfortunately they can't have both.

If Greece leaves the euro and defaults the odds increase that other countries will default and possibly follow the Greek exit. This is why the events in Greece are so detrimental to the global markets. Greece is setting a precedent that others can follow.

The weekend headlines have pushed the S&P futures to -5 on Sunday night and the dollar is rising again. There is still a lot of darkness before morning but it appears we could see further weakness in the U.S. markets.

The major U.S. indexes closed right on support on Friday as traders took profits off the table rather than leave them at risk from the weekend news events. The Dow has support at 12,750, S&P 1,340 and Nasdaq 2,900. All of the indexes closed within just a few points of those levels. Any material dip at the open would break those levels. However, we have seen the morning dips bought only to see the rebounds sold off in the afternoons.

There is no conviction on either side of the ledger. Sellers are waiting at resistance and buyers at support but neither can seem to overcome the other. Volume has been light and advance/declines have been relatively even. However, the new 52-week lows are rising as the overall market weakens. The blue chips are still holding much of their recent gains but the small caps are slipping away. Large cap tech stocks are also fading.

I am going to recommend again that we stand pat with the exception of the outstanding recommendation on Herbalife from last week. That stock has not yet hit the entry trigger at $49.50 but that should happen this week if Einhorn does not mention HLF on Wednesday.

Cash is a position.

Jim Brown

Send Jim an email



Current Portfolio


Current positions

Current positions


Current Position Changes


EXXI - Energy XXI (Covered Call)

The EXXI covered call has decreased in value from our initial entry at $3.40 to its current value at 65 cents. I am recommending we close that short call and write a new call at the same strike using the September options. The September $38 call is currently $2. That is not a lot of premium but after reducing our cost by $2.75 to $35.37 and receiving another $2 for the September strike that will give us a potential profit of nearly $5 if we are called away in September. If we are not called we will do it again.

Close EXXI Short June $38 Call, entry $3.40, exit .65, +2.75 gain.
Sell Short EXXI Sept $38 Call, currently $2.00. No stop.

Chart of EXXI


SBUX - Starbucks (Change Stop)

Starbucks has rebounded for the last couple of days. I don't want our protective put to evaporate completely. Change the stop loss on the protective June $55 put to $57.05. Maybe we can salvage some of the premium once SBUX gains speed.

Change stop on Long June $55 Put to $57.05

Chart of SBUX


New Short Put Recommendations


None


New Covered Call Recommendations


None


Long Term Recommendations


HLF - Herbalife (Short Put)

This is the same play description from last week. We are still waiting for HLF to trade at $49.50 to trigger the play.

Herbalife posted a +21% increase in revenue to $964.2 million and well above analyst estimates of $892.9 million. Earnings rose +26% to 88 cents and beat estimates of 70 cents. Earnings in Q4 rose +30.1% and Q3 +42.6%.

The stock was crushed after noted short David Einhorn questioned their sales plan on the conference call. I am pretty sure everyone understands that Herbalife is a multilevel. Einhorn questioned the status of their distributors and asked how many buy products for themselves rather than for resale. For the record, Herbalife responded with the following. Some 27% join to buy the product at wholesale for themselves. Another 61% buy for themselves but then resell products at retail to their friends and others. Only 12% sign up with the intention to build a big multilevel business. These numbers have been common knowledge for decades. Just because Einhorn questioned them does not mean they are bad.

Herbalife has 2.7 million distributors and sales in Q1 rose 21% and earnings +26%. That should be the end of the story. The business is booming because they have good products. Even if all 2.7 million distributors signed up just to buy the products it would still be a great business. If some portion of those are building a second income that is gravy because it involves signing up even more distributors and then getting them hooked on the products.

Because it was Einhorn asking the question the stock fell -33% and lost nearly $2 billion in market cap. If ANY other person on the call had asked the question there would have been no market reaction. Einhorn's reputation as a finder of super short opportunities caused massive investor flight from the stock. Shares had rallied from $50 to $75 over the prior three months so there was plenty of profit to be captured by prior investors.

I believe once the market cooperates and the Einhorn scare passes we will see HLF return to at least $60. It may not regain the new highs from the prior week but I do think it will rebound. HLF said it was going to buy $425 million in shares because of the severe undervaluation.

The risk point here is a speech by Einhorn on May 16th. If he does not mention HLF in his speech then the worst is probably over. If he does mention it negatively then we could see another leg down. May options expire on the 18th so I am going to recommend a protective put in the May cycle just in case. It should be VERY cheap when/if HLF hits the trade trigger at $49.50.

If Einhorn rains on the HLF parade we will close both positions on the 18th.

Do NOT enter this position until HLF trades at $49.50

Sell Short HLF NOV $55 Put, currently $15.00, no stop.
Buy Long HLF May $45 Put, no stop.

Chart of HLF


New Aggressive Recommendations


None


Existing Play Recommendations


Links to original play recommendation

GLD - Gold ETF (Short Put)

EXXI - Energy XXI (LT Covered Call)

RIG - Transocean (Short Put Spread)

SBUX - Starbucks (Short Put Spread)

XHB - Homebuilders ETF (Short Put)


Margin Requirements:

There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.

Here is the most common margin calculation for naked puts.

100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))

For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)


Prices Quoted in Newsletter

At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.

The prices quoted in the newsletter are the end of day prices in most cases.

When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.

For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.

For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.

All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.